Not just for giants: Strachan

Successfully managing assets in-house is not a function of fund size, but a matter of adequate processes and good governance, according to Equipsuper chief investment officer Michael Strachan.

Many funds in Australia adhere to the view that internalisation of asset management only makes sense when a fund reaches $30 billion to $40 billion in size, as the cost savings on asset management fees allow for investment in systems and investment staff.

At $6.5 billion, Equipsuper is not quite in that league yet, but the fund has managed a significant slice of its assets in-house for more than 25 years.

Currently, Equip’s team of seven investment specialists manages about a third of its assets in-house, including Australian equities, fixed income, cash, direct investments, such as infrastructure assets, and a futures overlay.

In an interview with theinstoreport, Strachan explains why he believes most of the criticism of in-house management is nonsense.

“I don’t think it is a size issue. [Equip] is $6.5 billion and when I joined it was a lot smaller,” he says.

“I think you’ve got to take a philosophical view about whether you are going to run an insourced model, an outsourced model or a hybrid model with a view of what you can do well internally.”

An oft-heard complaint is that super funds would find it difficult to fire internal managers if they underperformed.

But Strachan says it would be the same process as for any fund manager.

“How do you sack an internal team? Well, you can. You sack the CIO and replace him. It is no different,” he says.

Another commonly expressed criticism is that internal teams would ‘steal’ the ideas of their external fund managers.

“You hear people say: ‘Oh you guys get all your intellectual capital from other managers and copy them.’ Well, that is just BS,” Strachan says.

“The reality is we’ve all got our own mandates.

“If I would copy them, I would be increasing risk in the portfolio and in the fund, so you wouldn’t do it.

“Most of our portfolios tend to be core, so their tracking error is 1.5 to 2 per cent in equities. If we want a higher alpha manager, we just go and get one.”

“You’ve got to have the right culture because you are running an internal investment management business,” he says.

“You’ve got to have the right skill base and the right people and have a competitive remuneration structure, because the reality is that you are competing for talent with the rest of the investment management industry.

“If you get it right, it can be very cost-effective.”

Good governance is largely a matter of having effective oversight and having an investment committee in place is an important part of that process, he says.

He says his team’s investment decisions are reviewed by the investment committee under the same process used to assess the fund’s external managers.

“We have a very rigorous due diligence process. We have a very formal process and it is all documented,” he says.

“We get treated no different than any of our other external fund managers.

“We have our own mandates … and we get reviewed independently by the asset consultant, board and committee.

“You’ve got to have those checks and balances and it does work.”

Additional benefits

Besides cost efficiencies, there are other benefits of managing money in-house, Strachan says, including the ability to have a much more technical conversation with your external manager.

“One of the benefits of running money internally is that it makes you a better manager of managers,” he says.

“We are in the market, we own stocks, so when we are in discussion with our Australian managers, it is a very different conversation.”

Strachan and his team also manage direct assets and Equip owns ports as well as airports, which gives them first-hand information about the terms of the recent transactions in the market.

“We see a lot of deals that come across [our desks] and over time you build up this experience and get a pretty good idea of what is likely to work and what is not likely to work,” he says.

“One thing about investing is that grey hair helps.”

Like many super funds, Equip has a number of direct investments in infrastructure assets.

The fund owns 19 per cent in Flinders Port, which includes the port of Adelaide and six regional ports.

It also has exposure to Brisbane Airport and Melbourne Airport.

But recently asset consultants have been increasingly concerned about the high prices paid for infrastructure assets.

Strachan tends to agree with them.

“There are probably two big [transactions] that people are talking about: the Port of Botany and the Port of Kembla sale, where the EBITDA (earnings before interest, taxation, depreciation and amortisation) multiples were over 20 times,” he says.

“I know what these things can generate and personally I think it is overvalued.

“We wouldn’t pay that amount for an infrastructure asset, because with buying a port you are basically a landlord and they are regulated assets with regulated pricing structures.

“I don’t know how you can get a lot of upside unless you are going to push a lot more volume through them.

“I think a lot of it could be trophy assets as well, but as the New South Wales government you’ve done a really good job in selling these assets on behalf of the taxpayers.”

Strachan and his team looked into buying part of Port Kembla and put a valuation on the assets.

“We actually looked at Kembla and we know what we thought it was worth and it was a lot less than what it went for,” he says.

“I was just flabbergasted when I heard [how much was paid].”

A diverse background

Strachan joined Equip eight-and-a-half years ago and has a diverse background, having worked for commercial fund managers, corporate super funds and now a not-for-profit fund.

He even had a stint in the resources industry, which provided his entry into the asset management sector.

“I got a job as a resources equity analyst with what was then County Investment Management in 1992, staying there for nearly 10 years,” he says.

“We went through four different ownerships and the finally owner was Invesco. I ended up running all the diversified funds and structured products.”

But in 2002, the company decided to make a large number of its senior investment managers redundant, including Strachan.

“I ended up playing Mr Mum for 12 months and helping someone else setting up a hedge fund,” he says.

“Then I got approached about joining Rio Tinto’s staff fund in their inaugural CIO role and I worked there for nearly three years.

“I had a lot to do, not only with funds here and in New Zealand, but Rio had 33 pension funds globally and the four big ones were the US, the UK, Canada and here.

“I actually had a lot to do with the Canadian, US and UK funds as well.”

But then he got approached to work for Equip, which offered him the opportunity to manage money again.

“My background is funds management; I started in Australian equities and spent a lot of time running diversified funds,” he says.

“I actually wanted to run money again.

“Rio was a totally outsourced model; managing managers. But [Equip] has run money internally since 1988, so it has been over 25 years that we have been managing money.”

Strachan and his team run a number of separate portfolios for the fund.

“We actually run three Australian equity portfolios. One is a sustainable one, a SRI (socially responsibly investment) Australian equity portfolio,” he says.

“We run a core portfolio for our defined benefit and member investment choice options, and we also run basically an imputation fund for our pension product.

“We run two fixed interest portfolios: a core Aussie fixed interest and a short-duration Aussie fixed interest portfolio, which is predominantly designed for the pension product.

“We run cash, of course, and we also do a lot of direct investing.

“The other job we do is we have active allocation decisions. We also select managers and take them to the investment committee to be recommended.”

Equip has no plans to increase the percentage of assets managed in-house, he says.

“We manage about a third and it has always been like that. We’ve looked at it and I think that is about the right level,” he says.

“If you look at overseas funds, the big US and UK pension funds, where in-house management has been going on for quite a long time, it is the same. They manage about a third of it.

“There is no magical algorithm that you have to manage a third, but from a risk perspective I would be hesitant to have it more than that.”